LVTS, the Overnight Market, and Monetary Policy

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Operational events in the Large Value Transfer System (LVTS) almost always result in a disturbance of the regular flow of payments. The author explores the link between payment flows and the overnight interest rate. She also explores the way that payments system frictions affect the overnight interest rate. Payments system frictions arise because LVTS participants lack full information on their own payment flows and those of others. This uncertainty diminishes as the final end-of-day settlement nears. By borrowing earlier in the day in the overnight market, however, participants can insure against being short at the final end-of-day settlement. The author first develops a general framework describing the role that payment flows and payments system frictions have on the overnight rate and then empirically tests the implications of this model. She finds that LVTS payment flows are an important determinant of pressure on the overnight interest rate.